Keeping tabs on costs

By MARK FRYER

Love and marriage, horse and carriage, investment and jargon - some things just naturally go together.

Much of the terminology spawned by the investment business can be safely ignored but some terms are worth coming to grips with.

One bit of jargon that investors - and potential investors - can expect to see more of is "management expense ratio", or MER for short.

Unlovely as it sounds, this can be a useful bit of information for anyone thinking of putting money into managed investments such as unit trusts.

If the jargon doesn't appeal, think of the MER as the price ticket for investing through a manager, rather than doing it yourself. It matters because the MER comes out of a fund's returns, which means it come out of investors' pockets.

All other things being equal, a fund with a low MER will give investors a bigger share of the returns.

There's nothing new about the term, but it's one that is likely to be seen more often.

That's because the Investment Savings and Insurance Association, the organisation that represents many of the big fund managers and insurance companies, last month came out with a new standard detailing how managers should calculate the MER for their funds and present it to the public.

While it isn't a radical change, association chief executive Vance Arkinstall says he expects one result will be that fund managers will give the MER more prominence in the material they provide to investors.

In simple terms an MER is a way of taking the expenses involved in investing through a manager and wrapping them up in one figure, making it easier to see how much you're paying and simpler to compare funds.

The term applies to investments such as unit trusts, investment-linked insurance policies and superannuation schemes (but not workplace super) - the sort of things you buy and sell through a manager, rather than on the sharemarket.

Managers express MERs as a percentage - of the value of your investment, not the amount you originally put in. So, if a fund's MER is 1.5 per cent and your stake in that fund is worth $10,000, you know that management is costing you $150 a year.

You won't receive a bill for that amount, because management costs are taken out of your returns before you get them.

In theory, the investment statements and prospectuses put out by members of the association are already meant to show each fund's MER. In practice, things vary: while some investment statements show the figure clearly, others list various costs that may or may not apply and leave it to the investor to add them together.

Even under the new standard, managers still don't have to show the MER in the investment statement for their fund or funds (they have to show it in the more detailed prospectus, but that's something that few potential investors are likely to see).

However, the standard does require managers to provide a fund's MER for the past three years, if it has been around that long, in writing to anyone who asks, as well as a brief description of the purpose of an MER.

In practice, Arkinstall expects most managers to include it in their investment statements.

All of which means that, if you're thinking of investing in a fund and you're not sure what the charges are - ask. And if you're still not clear about the costs, think about choosing another fund.

New funds can estimate what their MER will be, but once they have completed one year they must use the actual figures.

Once you know the MER, bear in mind that it doesn't cover all the costs of investing. For one thing, it leaves out what the association describes as the "expenses ordinarily incurred by a person who directly invests in assets equivalent to the underlying assets of the fund".

So a share fund, for example, won't include brokerage costs in its MER, on the grounds that if you were buying the shares directly you would have to pay brokerage anyway. That means that a fund that turns over a lot of its shares every year will cost more than one that tends to buy and hold, even if they both have the same MER.

When working out the MER, fund managers also ignore any up-front fees or exit fees. Particularly if you're a short-term investor, those can add considerably to the cost of investing in a fund.

What the MER does include are the ongoing fees that will be deducted from the fund, or directly or indirectly charged to an investor. That includes fees received by the manager, the trustee, custodial or audit fees, and any ongoing commissions the fund pays to financial advisers.

Some funds invest in subsidiary funds and they will have to disclose both the MER of the overall fund and the average MER of the underlying funds too.

New Zealand still has a way to go compared with some countries where managers can't just show what their costs are as a percentage, but also have to detail what they cost in dollars and cents.

Regulators in some countries even run websites showing the impact of fees, but even without those refinements, seeking out the MER before investing does make the job of comparing managed fund costs a little easier.


* Email Mark Fryer